SCPF: Chinese Stocks rally across the board

BY LILIAN CO

Monthly Fund Commentary
22 May 2015

BY LILIAN CO

Momentum in China stocks accelerated in April after an encouraging speech by Premier Li and positive comments on the stock market by the People’s Daily (the Government’s mouth piece).  A shares continued to outperform H shares despite rich valuation.

The CSI 300 Index was up 17.2% while the MSCI China Index advanced 16.7 % during April, taking the year-to-date returns to 34.4% and 26.1% respectively. The run on H shares was triggered by the Government’s announcement that China mutual funds will be allowed to buy HK stocks direct.  In particular, H shares that traded at steep discounts to their dually listed A share counterparts and small/mid cap stocks that traded at steep discounts to their A share sector peers were up 50% or more in the month.  Interestingly, H to A share discounts actually widened even more as A shares ran even harder. SOE merger talks across a number of industries such as oil and gas, telecom and shipping excited A share investors more than H share investors.  The rally in April was across the board.  Many stocks went up as long as they traded at a big discount to their A share peers. This was unlike the rally last December which was concentrated to financial stocks only.

March macro data was still mixed. The PMI (purchasing manufacturing index) was up sequentially to 50.1, but export and electrical consumption were down 15% and 2.2% year on year, below market expectation.  The Government reacted with a surprise 100 basis point cut in reserve requirement ratio (RRR) during the month.  The last time there was an RRR cut of this magnitude was back in December 2008.  This action suggests that the Government is turning more aggressive regarding macro easing.  So far, the Government has announced either an interest rate or RRR cut each month since February.  The Investment Adviser expects this pattern to continue until the macro turns positive.

The Chinese regulator attempted to cool down the sizzling hot A share market by clamping down shadow financing offered by securities firms and expanding the supply of shares available for short selling. The news only had short lived negative impact on market sentiment.  On the contrary, news of INVESCO (an asset management company) raising US$1.8bn in China within weeks for a new QDII fund with a mandate to invest in A and H shares added further fuel to the already buoyant market sentiment.  Average daily stock market turnover shot up to almost HK$200bn in April, even higher than HK$165bn recorded at the peak in 2007.

The Fund returned 15.2% in the month.  Sector exposure to shipping, property and autos generated the majority of the return, up 2.6%, 2.4% and 2.2% respectively. Positions initiated last year in the shipping and Chinese property sectors finally paid off. They were re-rated on low valuations with improving underlying industry trends.  Profit was taken on shipping stocks as they hit their target prices.  The sector weighting was trimmed to 6.1% as of the end of April (from 8.1% in March). The latest weighting is 2%.  

The Investment Adviser is constructive regarding the market as they expect the economy to start responding to the macro easing in the second half of the year.  This is a typical six to nine month lag before the positive result of monetary easing (which was officially rolled out in November 2014) is filtered through to the real economy. They see any market pullback as a healthy correction after the strong run during April., After all, market P/E of the MSCI China remains reasonable at low teen levels and is supported by a highly accommodative monetary policy. Stocks have been re-rated so far on expectation of improving macro trend.  The next stage of the market re-rating will come from corporate earnings recovery, likely in the second half of the year.

The views and statements contained herein are those of LBN Advisers Limited in their capacity as Investment Adviser to the Fund as of 14/05/15 and are based on internal research and modelling.